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Australia: Regulator Recommends Electricity Market Rules Review to Hinder Retail Price Gaming. Electricity Price Impacts on Inflation ‘Significant’.

April 15, 2011

Yesterday, the State utilities regulator, IPART, announced high double-digit retail electricity price hikes in NSW, which will pile on the pain to households. 

In a major development, in their recommendations the State utilities regulator suggests that electricity market rules need reviewing.  This concern debunks the myth peddled by utilities and bought by many that price increases are unavoidable.

The Reserve Bank of  Australia (RBA) is unsurpisingly concerned about the effects of electricity price increases on core inflation, and has examined both the causes and the effects.  In a staff paper, published on the RBA website in the December Quarter 2010 Bulletin, the authors examine utilities prices.  It shows that Australia’s electricity price inflation rates are among the highest in the world – at an average annual price inflation rate of 5% in the decade 2000-2009, and over 10% for 2010.   

The authors conclude:

Large increases in the prices of utilities have been a notable feature of consumer price inflation in Australia in recent years, and further large increases are anticipated over the next few years. This follows subdued outcomes through most of the 1990s. The recent price rises reflect a range of factors, including the move towards cost-based pricing, the need to significantly increase investment to replace and expand infrastructure, and rising input costs. The direct impact of utilities price increases on aggregate inflation has been significant, and there is also some evidence of indirect effects, whereby rising utilities prices have led to higher input costs for firms, and eventually higher inflation in other goods and services. Inflation in Australian household electricity and gas prices since the 1990s has been towards the upper end of the range recorded in advanced economies, particularly over the past couple of years. Despite these increases, the level of electricity and gas prices in Australia does not appear to be particularly high compared with prices in a number of other advanced economies.

The RBA authors largely buy into the utilities story about the basis of price increases.  However, IPART suggests that they may share concerns that the National Electricity Rules:

May bias the decisions from the Australian Energy Regulator’s Determinations in favour of higher network costs for retailers.

Utility-led customer demand-side efficiency and response will be redundant and unincentivised for as long as the uncompetitive retail market persists with current pricing and regulatory models.  Utilities push for higher prices, and flawed regulation enables them to justify it. 

There is little pressure on utilities to change their business models for as long as regulators cede to regulated price increase demands and the market remains concentrated and uncompetitive.  As we have previously written, analysts have pointed out additional structural causes for Australian utilities pricing, including deficiencies with the models allowed as the basis for utilities to calculate their cost base to justify increased prices, including assumed cost of capital. 

We speculate that the broad thrust of this analysis is supported by IPART’s proposed recommendations.

There is no sign that utilities intend to change the fundamentals of their business models any time soon.  Support for ‘new’ energy efficiency markets from these players should be viewed with suspicion.  With limited competition, and market dominance by just a few large players, one might surmise that new such initiatives may largely be aimed at retaining market share and carving out profit from new Government subsidies.

Increases in electricity prices will, however, likely have some impact on consumer behaviour – leading to some marginal increase in energy efficiency and demand response.  However, those most impacted by price rises (as a percentage of income) are likely to be least able to respond. 

Also, ‘grid parity’ for solar power inches closer with improved installed costs and the increases in power prices – though the peak renewable energy technology body in Australia – the Australian Centre for Renewable Energy (ACRE)  – does not believe that grid parity will be reached in the near future.

Will the Australian Energy Market Commission now please stand up and examine the market rules?  It could be the most immediate opportunity to stem price inflation.

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